Tài liệu Trade-Off Financial System Supply-Chain Cross-Contagion: a study in global systemic

Trade-Off

Financial System Supply-Chain Cross-Contagion:

a study in global systemic collapse.

David Korowicz

30th June (revised) , 2012

Thi

Metis Risk Consulting & Feasta

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Metis Risk Consulting

Understanding, communicating and managing large-scale systemic risk

With support from:

The Foundation for the Economics of Sustainability

"Designing systems for a changing world"

www.feasta.org

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Overview

This study considers the relationship between a global systemic banking, monetary and solvency

crisis and its implications for the real-time flow of goods and services in the globalised economy. It

outlines how contagion in the financial system could set off semi-autonomous contagion in supply￾chains globally, even where buyers and sellers are linked by solvency, sound money and bank

intermediation. The cross-contagion between the financial system and trade/production networks

is mutually reinforcing.

It is argued that in order to understand systemic risk in the globalised economy, account must be

taken of how growing complexity (interconnectedness, interdependence and the speed of

processes), the de-localisation of production and concentration within key pillars of the globalised

economy have magnified global vulnerability and opened up the possibility of a rapid and large￾scale collapse. ‘Collapse’ in this sense means the irreversible loss of socio-economic complexity

which fundamentally transforms the nature of the economy. These crucial issues have not been

recognised by policy-makers nor are they reflected in economic thinking or modelling.

As the globalised economy has become more complex and ever faster (for example, Just-in-Time

logistics), the ability of the real economy to pick up and globally transmit supply-chain failure, and

then contagion, has become greater and potentially more devastating in its impacts. In a more

complex and interdependent economy, fewer failures are required to transmit cascading failure

through socio-economic systems. In addition, we have normalised massive increases in the

complex conditionality that underpins modern societies and our welfare. Thus we have problems

seeing, never mind planning for such eventualities, while the risk of them occurring has increased

significantly. The most powerful primary cause of such an event would be a large-scale financial

shock initially centring on some of the most complex and trade central parts of the globalised

economy.

The argument that a large-scale and globalised financial-banking-monetary crisis is likely arises

from two sources. Firstly, from the outcome and management of credit over-expansion and global

imbalances and the growing stresses in the Eurozone and global banking system. Secondly, from

the manifest risk that we are at a peak in global oil production, and that affordable, real-time

production will begin to decline in the next few years. In the latter case, the credit backing of

fractional reserve banks, monetary systems and financial assets are fundamentally incompatible

with energy constraints. It is argued that in the coming years there are multiple routes to a large￾scale breakdown in the global financial system, comprising systemic banking collapses, monetary

system failure, credit and financial asset vaporization. This breakdown, however and whenever it

comes, is likely to be fast and disorderly and could overwhelm society’s ability to respond.

We consider one scenario to give a practical dimension to understanding supply-chain contagion: a

break-up of the Euro and an intertwined systemic banking crisis. Simple argument and modelling

will point to the likelihood of a food security crisis within days in the directly affected countries and

an initially exponential spread of production failures across the world beginning within a week.

This will reinforce and spread financial system contagion. It is also argued that the longer the crisis

goes on, the greater the likelihood of its irreversibility. This could be in as little as three weeks.

This study draws upon simple ideas drawn from ecology, systems dynamics, and the study of

complex networks to frame the discussion of the globalised economy. Real-life events such as

United Kingdom fuel blockades (2000) and the Japanese Tsunami (2011) are used to shed light on

modern trade vulnerability.

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Trade-Off

Financial System Supply-Chain Cross-Contagion: a study in global systemic collapse.

Contents

I. Introduction 4

I.1 The living fabric of exchange

I.2 Complexity & risk

I.3 This study in context

II. Supply-Chain Failure and Repair 14

II.1 The connectedness of things: natural disasters and blockading truckers.

II.2 Rips & Repair

III. The Ecology of the Globalised Economy 21

III.1 The dynamical state of the globalised economy, stability & critical transitions

III.2 A trophic web model of the globalised economy

III.3 Path dependence, and economic contraction as a critical transition

III.3.1 Reverse economies of scale in critical infrastructure

III.3.2 Debt deflation

III.3.3 Trust radii in expansion & contraction

III.4 Secondary keystones & scale-free networks

III.4.1 The global banking system

III.4.2 Trade networks

III.5 What is collapse?

IV. Converging Crises in the Financial & Monetary System 40

IV.1 Credit over-expansion & imbalances

IV.2Peak oil and its economic implications

IV.3Real wealth, proxy wealth & the end of credit

V. Financial System Supply-chain Cross Contagion:

A Eurozone Collapse Scenario 55

V.1 The bubble bursts

V.2 Central banks & governments to the rescue?

V.3 Financial system supply-chain contagion

V.4 Supply-chain contagion

V.5 Supply-chain financial system feedback

V.6 Time & irreversibility

VI. Risk, Constraints and a Conclusion 72

VI.1 Some thoughts about risk

VI.2 Lock-In

VI.3 Conclusions

Acknowledgements 75

References

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I. Introduction

A networked society behaves like a multicellular organism...random damage is like lopping off a

chunk of sheep. Whether or not the sheep survives depends upon which chunk is lost....When we

do the analysis, almost any part is critical if you lose enough of it.... Now that we can ask

questions of such systems in more sophisticated ways, we are discovering that they can be very

vulnerable. That means civilisation is very vulnerable.

Yaneer Bar-Yam1

,

New England Complex Systems Institute

I.1 The Living Fabric of Exchange

The Irish economy, the German economy and the UK, US and Chinese economies do not

exist, except by virtue of their integration in the globalised economy. Conversely, each is a

localised expression of a global system. At any moment a myriad of final and intermediate

goods, commodities, information and people is moving back and forth across borders.

Without those flows, which maintain socio-economic function and complexity, economies

would quickly collapse.

Here we make a distinction between our imagined communities, in particular the nation

state and the psycho-drama within and across nations, and our real dependencies, which

are globalised. National economies can have local character and limited degrees of

freedom, but they exist inter-dependently, just as a heart or lung cannot exist apart from

the body and still retain its original identity.

The nature of this integration has been evolving in ways that are reflected in common

conversations about the world becoming so much more complicated, globalisation, ‘the

world being flat’, and the speed of change in the world. Broadly, we can say that the

globalised economy has been growing in complexity. This can be associated with growing

connectedness, interdependence and speed. There are many definitions of socio-economic

complexity and quite a bit of debate as to its nature. At the most general we could start

with the following:

Complexity is generally understood to refer to such things as the size of a society, the

number and distinctiveness of its parts, the variety of specialised roles that it

incorporates, the number of distinct social personalities present, and the variety of

mechanisms for organising these into a coherent, functioning whole. Augmenting any of

these dimensions increases the complexity of a society.

Joseph Tainter2

We can catch a fragmentary glimpse of this via Eric Beinhocker who compared the number

of distinct culturally produced artefacts produced by the Yanomamo tribe on the Orinoco

River and by modern New Yorkers. The former have a few hundred, the latter, tens of

billions3. John Gantz notes the massive increase in the “internet of things” such as cars,

ovens, payment and ordering systems, electric grids and water systems, rather than people.

The number of connected devices has risen from 2 billion in 2005, to 6 billion in 2010, and

is projected to be (conditions allowing) 16 billion by 20154.

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Consider that a modern auto manufacturer has been estimated to put together 15,000

individual parts, from many hundreds of screw types to many tens of micro-processors.

Imagine if each of their suppliers put together 1,500 parts in the manufacture of their input

to the company (assuming they are less complex), and each of the suppliers to those inputs

put together a further 1,500. That makes a total of nearly 34 billion supply-chain

interactions (15,000 x 1,500 x 1,500), five times the number of people on the planet. This is

a highly imperfect example but it signals the vast conditionality upon which modern

production depends.

The globalised economy is a singular recursive network or fabric of relationships between

people and things. Let us take a more discursive example. Mobile devices, now ubiquitous,

represent the culmination of 20th-century physics, chemistry and engineering. They signify

thousands of direct - and billions of indirect - businesses and people who work to provide

the parts for the phone, and the inputs needed for those parts, and the production lines

that build them, the mining equipment for antimony in China, platinum from South Africa,

and zinc from Peru, and the makers of that equipment. The mobile device encompasses the

critical infrastructures that those businesses require just to operate and trade - transport

networks, electric grids and power-plants, refineries and pipelines, telecommunications

and water networks - across the world. It requires banks and stable money and the people

and systems behind them. It requires a vast range of specialist skills and knowledge and

the education systems behind them. And it requires people with income right across the

world, not just as producers, but also as consumers who can afford to share the costs of the

phones and associated networks - there are economies of scale right through the diverse

elements of the globalised economy. Those consumers can only afford the devices because

they ply their trade through integration in the globalised economy.

The mobile device feeds back into the globalised economy, re-shaping and transforming it.

It is the building block for new levels of complexity when it combines with other things to

form new businesses and new economies of scale. It co-adapts with societies and

economies, intertwining, shaping how we live in and understand the world. The mobile

device is not a thing in the globalised economy, but a dependent expression of it.

The speed of interaction between all these parts of the globalised economy has been getting

faster. Automatic trading occurs over milliseconds, and financial and credit shocks can

propagate globally in seconds. Within a minute of deciding to talk to a friend on the other

side of the world, our conversation can begin. One of the major transformations in

business is that lean inventories and tight scheduling means many businesses and

industries hold hardly any stock. Automatic signals go from check-out counters, to

warehouses, to suppliers who ramp production up or down to meet demand. That supplier

too sends signals to their suppliers who also run Just-In-Time logistics (JIT).

It has been estimated that a modern industrial city only has about three days of food for its

inhabitants in situ. Later we will consider in more detail the blockade of fuel depots in the

UK in 2000, when the UK Home secretary Jack Straw accused the blockading truckers of

“threatening the lives of others and trying to put the whole of our economy and society at

risk”. This was not hyperbole. As the protest evolved over about ten days, the UK's Just-in￾Time fuel distribution system started to break down. Supermarkets, which had also

adapted to Just-in-Time re-supply, began to empty. Supplies and staff could not reach

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hospitals, forcing emergency-only admission. If it had gone on for only a few days longer,

large parts of UK industry would have shut down as the normal operation of re-supply

ground to a halt. One of the most advanced and complex societies on the planet was within

days of a food security crisis. In section II, various examples will be used to demonstrate

how growing complexity, interdependencies within socio-economic systems and the

increased speed of processes can cause widespread and rapid contagion if the ‘right’ critical

piece fails.

In all the vast complexity of the globalised economy, there is no person or institution in

control, or who knows how it all fits together, for it is far beyond our comprehension.

Facebook, for example, does not need to know how to make an electric grid work, or how

to process antimony, yet nevertheless they are all connected through diverse and

unfathomable relationships. Each person, business, institution and community acts within

their own niche; with their evolutionary heritage and their common and distinct histories;

with their acquired skills and assets; and through physical and cultural networks. What

emerges at a large scale is the globalised economy. We are both contributors to, and

dependent upon, the functioning of that economy.

This is just Adam Smith’s invisible hand at work, or in modern scientific parlance, an

example of self-organisation in a complex non-equilibrium system. In particular, the

globalised economy is an example of a complex adaptive system (CAS). A non-equilibrium

system is one prone to change and transformation. It is a system, because there is a level of

overall integration and identity, and co-dependence between parts. They are complex and

adaptive because they are composed of dynamically (not static) interacting parts

(sometimes called nodes) that change their individual and collective behaviour over time.

A person is a CAS, so too is a collection of them (at a sporting event, as part of traffic or as

a nation), so is a company, and so is an electric grid. An ant colony is a CAS, as is the

evolution of the earth’s biosphere. They exist interdependently, mixing chance and

necessity over a universe of scales. What maintains a CAS is its internal stability and the

transformation of energy and resources.

Despite the ostensible change over our own lives - indeed, we live in a culture that prizes,

and an economy that delivers continual novelty - what is remarkable is how stable that

evolution has been. How can we talk of stability when there has been so much change: new

technologies, the rise of China and evolving social mores? But we would not make such on￾trend assumptions (technological evolution, economic growth), nor invest as though we

expect them to continue (how society educates its children, new infrastructure, pensions),

unless we felt comfortable that there was some form of macro-system stability. Within that

intuition of stability, we can have booms and busts, break-out technologies and bloody

wars, but over the medium to long term we can assume there is reversion to the trends

embodied in the macro-system evolution. Without such stability the high complexity de￾localised JIT integration could not have occurred: try crocheting on a roller-coaster.

Stepping back, what can be observed is that a new phase in global growth began to take off

in the early 1800s. It was faster and more sustained than ever before1

. Because the growth

was exponential, each year’s 3% growth added more goods and services than the year

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Maddison estimates that Gross World Product grew 0.34% between 1500 and 1820, 0.94% (1820-1870), 2.12%

(1870-1993), 1.82% (1913-1950), 4.9% (1950-1973), 3.17% (1973-2003), and 2.25% (1820-2003).